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Note to Candidates In this volume, I have attempted to reduce the answers to the minimum that a candidate would have to write to earn full marks on each question. The answers are intended as both an assessment tool and a learning tool. Please use them accordingly. If you believe that there is an error in an answer contained here, please consult my errata page to see if your concern has been addressed:
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Answer Question 1-A on This Page
Derivative
Given Elcius’ expectations, for each derivative determine the position that he
should take.
(Note: consider each derivative separately)
(Circle one each)
Justify each response.
Six-month VIX call options
Buy
Sell
• Call values increase with increasing underlying price
• Strong, negative correlation between VIX level, equity prices
Falling equity prices imply rising VIX
Six-month VIX put options
Buy
Sell
• Put values decrease with increasing underlying price
• Strong, negative correlation between VIX level, equity prices
Falling equity prices imply rising VIX
Six-month VIX
futures contracts
Long
Short
• Long futures increase with increasing underlying price
• Strong, negative correlation between VIX level, equity prices
Falling equity prices imply rising VIX
Answer Question 1-B on This Page Determine the value of the swap to Busti 75 days after inception. Show your calculations.
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Answer Question 1-C on This Page Determine whether Busti will pay or receive the settlement on the swap.
(Circle one)
Pay
Receive
Calculate the settlement amount for Busti. Show your calculations.
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Answer Question 2-A on This Page Explain why the empirical duration of the BML bonds is different from the modified duration of the bonds, based solely on the information given. (Note: no calculations required)
• Change of yield for the bond is less than benchmark yield change (115bp < 130bp) Smaller yield change means smaller price change
Smaller price change means shorter empirical duration
Answer Question 2-B on This Page Determine whether Sutherland should choose a bullet structure,
a barbell structure, or a ladder structure for the AUD bond portfolio. (Circle one)
Bullet
Barbell
Ladder
Justify your response.
• Small yield change at 15-year maturity Bullet portfolio will lose little to no value
• Barbell and ladder hold long-duration bonds and short-duration bonds Long-duration bonds will lose more value than short-duration bonds will gain
Barbell and ladder portfolios will lose value
Answer Question 2-C on This Page Using the data in Exhibit 3, calculate the G-spread on the corporate bond (in basis points). Show your calculations.
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Answer Question 2-D on This Page Calculate the expected 6-month holding period return on Sutherland’s proposed investment in XKX bonds. Show your calculations.
3.8879%
Note: two decimal places (3.89%) are sufficient to earn full marks.
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Answer Question 3-A on This Page Determine the
most appropriate portfolio structure
for Milenković given his beliefs and objectives.
(Circle one)
For each structure not selected, state one reason why it is not appropriate.
Note: restating case facts without additional
support will not receive credit.
(Note: the space next to the chosen structure should be left blank.)
Long only
• Believes short run equity risk premium might be negative Requires short positions to capture
– or –
• Milenković does not want his active position in any stock to be
limited by that stock’s weighting in his benchmark. In a long-only strategy, the minimum position weight is zero, so the maximum underweighting (active position) is limited to the stock’s weighting in the benchmark.
130/30 long
extension
Low risk market neutral
Milenković wants to maintain some beta exposure. The beta exposure in a market-neutral strategy is zero, which doesn’t achieve this objective.
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Answer Question 3-B on This Page
Judge whether each of Toàn’s statements is accurate or inaccurate.
(Circle one each)
Support each judgment.
Statement 1
Accurate
Inaccurate
• Market-neutral means money-beta is zero
Not necessarily zero net investment
Statement 2
Accurate
Inaccurate
• Market-neutral portfolio: β ≈ 0
Low σ of returns or low correlation with market returns
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Answer Question 4-A on This Page Determine which strategy
is most appropriate for Frías’ portfolio.
(Circle one)
Calculate the cost of the chosen strategy (in PAB) per EUR 1,000.
Show your calculations.
Protective put
Collar
Long seagull spread
PAB 15.31−
Short seagull spread
Answer Question 4-B on This Page Determine which options(s) Canouse should buy, if any, and which option(s)
Canouse should write, if any, to implement Samms’ suggested strategy.
Buy
Write
Type (Call/Put)
Strike
Type (Call/Put)
Strike
Call
PAB 0.8933
Put
PAB 0.7297
Calculate the total cost to implement the strategy (in PAB). Show your calculations.
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Answer Question 4-C on This Page Determine whether Abu Layla should accept or reject the carry trade.
(Circle one)
Accept
Reject
Justify your choice. Show your calculations.
• Arbitrage-free 6-month forward rate = BRL/PAB 5.4651 Less than expected spot rate
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Answer Question 5-A on This Page Determine, based on her observed bias, whether Boudiaf will
most likely accept or reject Hasan’s recommendation. (Circle one)
Accept
Reject
Justify your response.
• Believes her employer’s stock is a good investment • Confirmation: will stick with her belief
Answer Question 5-B on This Page Determine which bias Hyon-Jin most likely displays.
(Circle one)
Illusion of control
Hindsight
Framing
Support your choice.
• Rewriting history “Knew” a bad result would be bad Thinks she agreed with a good decision when she hadn’t
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Answer Question 5-C on This Page Determine whether Hasan should most likely accommodate or mitigate Rogic’s bias.
(Circle one)
Accommodate
Mitigate
Justify your determination.
• Representativeness is a cognitive error Easier to mitigate than emotional biases
• Mitigation generally better than accommodation
Answer Question 5-D on This Page
Identify the most likely emotional bias that Ryan’s actions reveal.
Emotional bias:
Endowment
Support your response.
• Target price is well above the market price • Attributed to “owing it to his parents’ legacy”
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Answer Question 5-E on This Page
Identify the most likely cognitive bias from which Bean suffers.
Cognitive bias:
Conservatism
Justify your response.
• Retains original assessment: good investment • Ignores contrary evidence: recent bad performance
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Answer Question 6 on This Page Determine the
most appropriate equity investment
for the RIA. (Circle one)
For each investment not selected, state one reason why it is not the most appropriate. Show your calculations.
Note: restating case facts without additional
support will not receive credit.
(Note: the space next to the selected investment should be left blank.)
DKN
• Budget stabilization funds need high liquidity
Cash needs are unpredictable • DNK has moderate liquidity
ZPX
GRY
• Return objective is at least inflation: 2% • Expected portfolio return is 1.985% < 2%
LSQ
• Investments should have low price correlation with budget
revenue source • Price correlation with petroleum is +0.80
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Answer Question 7-A on This Page
Determine whether each comment is accurate or inaccurate.
(Circle one each)
For each inaccurate comment, identify all inaccurate part(s) of the comment.
(Note: do not consider omissions to be inaccuracies.)
(Leave the space next to any accurate comment blank.)
Comment 1
Accurate
Inaccurate
• It also includes ex post calculations such as VaR, CVaR
Comment 2
Accurate
Inaccurate
• Absolute return of our portfolio is explained by performance measurement
Comment 3
Accurate
Inaccurate
• Calculating relative ratios, such as information ratio and capture ratios, is part of appraisal
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Answer Question 7-B on This Page Calculate the geometric excess return for the Plan’s portfolio compared to its benchmark portfolio. Show your calculations.
0.53%
Answer Question 7-C on This Page Compare the return attributable to the asset owner
to the return attributable to the investment managers. (Circle one)
Less than
Equal to
Greater than
Justify your conclusion. Show your calculations.
• Return attributable to owner: 0.69% • Return attributable to managers: −0.13% • 0.69% > −0.13%
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Answer Question 8-A on This Page Based on Abdujalilov’s categorization, determine the most likely
time period for the Plan to achieve the target allocation to KH. (Circle one)
Short-term
Intermediate-term
Long-term
Support your determination.
• KH has a 5-year investment period
Answer Question 8-B on This Page
Identify the most appropriate proxy for the Plan’s private real assets investment. (Circle one)
Public REITs
High-yield bonds
Commodity futures
Support your identification.
• Private real assets: timber, commodities, farmland, energy, infrastructure assets o Not real estate, bonds
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Answer Question 8-C on This Page Evaluate the appropriateness of Abdujalilov’s approach for investing in private real assets and private credit, given his investment goals for those asset classes. Inappropriate
• Investment value will fluctuate from 0% to ~15% to 0% of portfolio value o Will not maintain 15% investment
Answer Question 8-D on This Page
Considering the Plan’s liquidity requirements, for each asset
class Abdujalilov is considering, determine whether
he should most likely increase or decrease the allocation to that
asset class. (Circle one for each asset class)
Justify each determination with one reason.
Show your calculations.
Bonds
Increase
Decrease
• Liquidity need: 5.6% • Available liquidity: 4.365% • Liquidity increase must come
from cash, bond coupons
Public Equity
Increase
Decrease
• Must reduce allocation to existing
assets • Cash, bonds should increase • Real estate, private equity are
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Answer Question 9-A on This Page
Identify two factors of the Plan that will most likely contribute to:
i. an increase in the Plan’s ability to take risk
1.
• Plan is overfunded 2.
• High ratio of active employees to retired employees
– or –
• High percentage of active employees
– or –
• Low percentage of retired employees
ii. a decrease in the Plan’s ability to take risk
1.
• Limited time horizon
– or –
• Closed to new employees 2.
• Lump-sum payout option 3.
• Payments adjusted for inflation
(Note: any two of the above identified factors for a decrease are sufficient.)
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Answer Question 9-B on This Page Formulate the time horizon section of the Plan’s IPS. Two-stage, long-term
• Stage 1: today until the last eligible worker retires • Stage 2: after stage 1 until final pension payment
Answer Question 9-C on This Page
Discuss two factors that will most likely contribute to an increase in the Plan’s liquidity needs.
1.
• Payments adjusted for inflation Higher inflation than assumed
Higher payments 2.
• Lump-sum payout option Possible higher immediate payments than assumed
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Answer Question 10-A on This Page Calculate the after-tax value of the Millers’ portfolio upon liquidation, assuming that their expectations hold. Show your calculations.
PAB 4,442,273
Answer Question 10-B on This Page Calculate the after-tax value of the Andrades’ portfolio upon their retirement, assuming that their expectations hold. Show your calculations.
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Answer Question 11-A on This Page
Based on Saaif’s analysis, for three of the
components of implementation shortfall, determine which broker
is preferable. (Circle one for
each component)
Explain each choice.
Delay cost
Strain
MT
Cannot be determined
• Strain: 0.88% • MT: 1.24%
Trading cost
Strain
MT
Cannot be determined
• Purchases
o MT: −0.51% o Strain is 1.89%
• Sales o MT: 0.87% o Strain: 1.32%
Opportunity cost
Strain
MT
Cannot be determined
• Opportunity cost is zero or positive. • Fully executed trades
o Strain: 76% o MT: 70%
• Partially executed trades o Strain: 13% unfilled o MT: 18% unfilled
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Answer Question 11-B on This Page
For each manager, determine which
algorithmic trading approach is most
appropriate. (Circle one for each manager)
Justify each selection.
Molina
Scheduled
Opportunistic
Arrival price
Dark
SOR
• Opportunistic handles large trades, market orders
o Generally ensures entire trade is filled • Scheduled, arrival-price, SORs best for small trades • Dark pools may not fill entire trade
Takano
Scheduled
Opportunistic
Arrival price
Dark
SOR
• SOR handles small trades, limit orders, multiple
volatile venues • Scheduled, opportunistic, arrival price, dark pools
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Answer Question 12-A on This Page
Based on Kin’s observations and
projections, estimate the most likely level of real
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Answer Question 12-B on This Page
For each building block, determine what change Kin is likely to make for
this year’s estimated value compared to last year’s estimated value.
(Circle one each)
For each value that is expected to change, justify your indicated change.
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Answer Question 13-A on This Page Based on the data in Exhibit 1 and Miller’s criterion, determine which
account Granitto should choose to hold the new investment. (Circle one)
Taxable
Tax-deferred
Does not matter
Justify your determination. Show your calculations.
( ) ( )Taxable Sharpe ratio 0.68 Tax-deferred Sharpe ratio 0.67>
Answer Question 13-B on This Page Determine how Relucio’s economic net worth
compares to her accounting net worth in Exhibit 2. (Circle one)
Less than
Equal to
Greater than
Support your determination. Show your calculations.
( ) ( )Economic net worth XCD 9,900,000 Accounting net worth XCD 10,000,000<
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Answer Question 13-C on This Page i. Identify one bias exhibited by Relucio that Miller’s suggested benchmark would most likely
help to highlight.
Home-country bias ii. Identify one of
Relucio’s investment goals that Miller’s suggested benchmark would most likely reflect more accurately than Relucio’s suggested benchmark.
Explain why Miller’s benchmark would likely be more accurate than Relucio’s benchmark for that goal.
Minimizing
diversifiable risk
• Global market-value weighted index will minimize
diversifiable risk • Domestic stock/bond index will not do so